Christine Lagarde: ECB interest rates to remain at their present levels

Any adjustments to the key ECB interest rates will take place some time after the end of our net purchases under the APP and will be gradual. The path for the key ECB interest rates will continue to be determined by the Governing Council’s forward guidance and by its strategic commitment to stabilise inflation at two per cent over the medium term. Accordingly, the Governing Council expects the key ECB interest rates to remain at their present levels until it sees inflation reaching two per cent well ahead of the end of its projection horizon and durably for the rest of the projection horizon, and it judges that realised progress in underlying inflation is sufficiently advanced to be consistent with inflation stabilising at two per cent over the medium term.
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ECB tries to get its bearings in the fog of war. ECB scales back stimulus plan as Ukraine war drives up inflation expectations. Bond markets view moves as hawkish while Lagarde calls Russia’s invasion a ‘major shock’ to eurozone economy.

The European Central Bank has scaled back its bond-buying stimulus plan in response to inflation being driven up by the war in Ukraine, while giving itself more flexibility on the timing of a potential interest rate rise this year.

“The Russian invasion of Ukraine is a watershed for Europe,” the ECB said in a statement after its governing council’s meeting in Frankfurt on Thursday, adding that it would “take whatever action is needed . . . to pursue price stability and to safeguard financial stability”.

Analysts interpreted the move to speed up the ECB’s exit from buying more bonds as a signal that it could raise interest rates in the fourth quarter in an effort to contain soaring inflation — which would be the first such move for more than a decade.

However, the ECB also gave itself more leeway to wait longer before raising interest rates after its bond-buying ends. “It is a bit of a mixed message, even though the market has interpreted it as hawkish overall,” said Dirk Schumacher, head of European macro research at Natixis.

Investors responded by selling eurozone bonds, pushing Germany’s 10-year yield to 0.27 per cent, the highest in more than three weeks. Riskier eurozone debt was also hit, with Italian 10-year yields climbing 0.2 percentage points to 1.89 per cent. Bond prices fall when yields rise.

“A faster winding down of the asset purchase programme will perhaps come as a surprise to market participants who expected an ECB capitulation in the face of weaker growth forecasts,” said Seema Shah, chief strategist at Principal Global Investors.

The euro briefly rose after the ECB announcement, before falling 0.6 per cent to $1.1013 against the US dollar.

Christine Lagarde, ECB president, said Russia’s invasion of Ukraine had created “a major shock” for the eurozone economy, adding that the central bank was forecasting higher inflation and lower growth over the next three years.

Setting out a quicker reduction in its bond-buying plans this year, the ECB said it would reduce asset purchases to €40bn in April, €30bn in May and €20bn in June. Its earlier plan was to steadily reduce net purchases from €40bn a month in April to €20bn a month from October.

It could stop adding to its existing €4.6tn bond portfolio in the third quarter “if the incoming data support the expectation that the medium-term inflation outlook will not weaken even after the end of our net asset purchases”.

The separate €1.85tn emergency bond-buying scheme launched in response to the coronavirus pandemic would stop net purchases as planned at the end of March, it said.

However, the central bank dropped a commitment to end asset purchases “shortly before” it raises interest rates, saying instead that any change to rates would be “gradual” and come “some time” after asset purchases end, which Lagarde said could mean months, or a week later.

The war in Ukraine has prompted some economists to warn about the risk of stagflation, in which a supply-side inflationary shock is combined with stagnant growth. This leaves the ECB in a difficult position, torn between the desire to tackle inflation that is expected to stay well above its 2 per cent target until at least next year and wanting to support the economy.

The ECB cut its growth forecast for this year to 3.7 per cent, down from 4.2 per cent, and Lagarde said high inflation could put more downward pressure on demand. It raised its forecast for inflation this year from 3.2 per cent to 5.1 per cent. But crucially it predicted inflation would fade to 2.1 per cent next year and 1.9 per cent in 2024 — meaning it still has not fulfilled a key condition to raise interest rates.

“Inflation could be considerably higher in the near term,” Lagarde said. “However, in all scenarios, inflation is expected to stabilise around our target by 2024.”